Friday, February 26, 2016

Oil Prices and Policy Stimulus Hopes Elevate Markets

Higher oil prices, soothing central bank/G20 commentary and better US economic
data all helped European and US equities climb higher this week. On Friday, the
S&P500 tested above the key 1950 level that has repeatedly provided strong
resistance over the last several weeks as global markets looked to put the
rough start to 2016 in the rear view mirror. Treasury demand remained
noticeably firm into month end, especially in light of the improving risk
appetite by investors and a string of stronger than expected US data later in
the week. Sovereign bond prices did slip on Friday, but have still largely
consolidated the safe haven bids seen here in early 2016, keeping the US 10-year
around 1.75%. All three of the major indexes closed about 1.5% higher for the
week.

Data out this week painted a somewhat confusing picture of the real condition
of the US economy. The February preliminary Markit factory PMI reading told us
what we already knew: US manufacturing faces very tough sledding. The survey
sank to 51.0, its lowest reading since late 2012. But it was Markit's February
preliminary services PMI that really freaked people out: the index sank into
contraction at 49.8, and Markit Chief Economist Chris Williamson warned the
survey data show a significant risk of the US economy falling into contraction
in the first quarter. February consumer confidence fell to the lowest level in
seven months, with notable declines in the present situation and future
expectations components.

On the more positive side, the preliminary January durable goods orders came in
at +4.9%, the strongest gain in nearly a year, more than reversing the -4.6%
plunge seen in December. The revisions to fourth quarter GDP were a mixed bag,
with the headline figure better but spending a bit lower. The second reading of
Q4 US GDP defied expectations to the upside, rising to +1.0% from the +0.7%
advance figure. Most of the revision higher was attributed to the volatile inventories
and trade components. The January personal consumption measure remained very
healthy at +2.0%, and personal income accelerated +0.5% from the flat December
reading. Core PCE - the Fed's preferred ruler for measuring inflation - was
surprisingly strong in January, rising to +1.7% from +1.5% in December, the
fastest m/m acceleration seen since late 2012.

January inflation data out of the euro zone suggested the disinflation
predicted by ECB Vice President Constancio last week was at hand. The total euro
zone measure was a mere +0.3% y/y, while preliminary February readings from
Spain, France and four major German states saw negative y/y readings. The
readings further strengthened the case for more easing from the ECB next month,
even as markets express more and more uneasiness with negative rate policies.
The strengthening dollar seen over the prior two weeks continued this week,
with the relatively strong US GDP and PCE data on Friday pushing EUR/USD back
below 1.0950 and back into the range seen in December and January.

Expectations have been building for weeks if not months that Beijing would be
forced to add additional stimulus of some kind in order to deal with the
continuing Chinese slowdown. Guessing has focused on RRR cuts, more medium-term
liquidity injections and possible fiscal policy moves. There were reports that
PBoC staff were recommending the government increase the fiscal deficit to
4%/GDP from the 3%/GDP currently targeted in 2016, although finance ministry
officials tempered these hopes. Until Thursday, the Shanghai Composite had
remained more or less calm since late January. Tightening liquidity conditions,
driven by a spike in short-term money market rates - the overnight repurchase
rate spiked by 16 basis points to 2.12% - sparked a 6.4% decline in Shanghai.
Interestingly, the sell-off did not travel to Europe and the US, with equities
in both regions up sharply on Thursday.

Saudi Arabia, Russia and other major OPEC producers worked hard to consolidate
support for the proposed oil production freeze agreement announced last week.
Iraq remains non-committal, while Iran ramped up its negative rhetoric. Iran
Oil Min Zanganeh called the plan "a joke," while various OPEC
officials conceded that Iran might need individual attention in negotiations
for a freeze. Parties to the agreement will meet in mid-March to negotiate a
formal deal. On Friday, Brent tested as high as $37 and WTI briefly ticked
above $34.50 for three-week highs, but by and large prices were well contained
within the ranges seen through the month of February.

Cable made fresh seven-year lows every day this week, closing out Friday around
1.3850, forced lower by nervousness about the upcoming referendum on the UK's
continued membership in the EU. Political jawboning and constant polling kept
the subject of Brexit in headlines, but the biggest development was London
Mayor and Conservative Party stalwart Boris Johnson backing the anti-EU camp.
Citigroup suggested that Brexit risk rises to 30-40% from 20-30% prior with
Johnson's endorsement. Polls were very tight: a BMD/Standard poll on the EU
Referendum showed 44% of respondents opting to stay in the EU, while 41% wanted
to leave, while a YouGov poll saw 37% in favor of staying versus 38% for
Brexit.

Earnings season is winding down with reports from the largest US retailers.
Decent results from Macys, Kohls, Best Buy and JC Penny helped boost the shares
of a broad spectrum of retail names. Macy's topped its recent guidance for the
quarter and offered FY guidance that was slightly ahead of expectations. Comps
were down more than 4%, but again this slightly beat consensus views. Kohls
raised its dividend and managed to deliver (barely) positive sales comps. Best
Buy's comps were negative, although it also launched a big new buyback and
raised its dividend. Lowe's and Home Depot both had positive quarters, aided by
continuing strength in the housing market. Shares of Hewlett-Packard sold off
hard after the firm disclosed ugly revenue declines with its first-quarter
results.

After years of negotiations, fallen Japanese titan Sharp reached a deal to sell
itself to Chinese firm Foxconn (formally known as Hon Hai Precision Industry)
for around $6 billion. But then in a very rapid reversal, shares of Sharp gave
up the 15% or so they had gained over the last month on talk the deal was
finally closing when Foxconn said it would postpone the arrangement until it
had clarified some "new material information" from Sharp, reportedly
sizable undisclosed liabilities. Honeywell and United Technologies confirmed
press reports that the two companies had discussed a potential merger deal but
talks stalled given very significant regulatory hurdles and considerable
customer concerns. UTX's CEO went as far as to appear on CNBC to say that a
merger with Honeywell just "ain't going to happen." Honeywell
confirmed that it had offered $108/shr in cash and stock, and would continue to
pursue a combination. London Stock and Deutsche Boerse said they were holding
talks about a potential merger of equals, which would create a combined group
worth nearly $28 billion.